Professor Ross Garnaut has published a seminal paper on the future demand for resources we can expect to emanate from China in the Agricultural and Resource Economics Journal and the news is not terribly bright. Below find the article’s abstract. Below that a longer version with the section of the paper that matter displayed and for the real masochists, below that, the full paper.
So far as I can tell, Australia is ill- prepared for this eventuality.
Here is the Abstract:
Commodity prices are formed by the interaction of global economic growth and costs of expanding supply of commodities. They tend to be high for long periods when global average growth rates are high, and low for long periods when growth rates are low, and to fluctuate around these averages as short term demand departs from expectations. The growth of advanced developing countries is especially influential in determining global demand for resources. Exceptional growth and resource intensity of China have been the main determinants of high energy and metals prices since about 2003. Short term cyclical factors have pushed energy and metal prices higher still, because markets did not anticipate the strength of Chinese demand and supply takes time to catch up. The high resource intensity of Chinese growth has been the result of high investment rates and rapid increases in urban population and the export share of production. Strong growth is likely to continue although at slowly receding rates, but growth will become less resource intensive, leading to moderation of global commodity prices. Strong growth in China and the world are at risk if effective policies are not adopted to break the nexus between economic growth and pressure on the environment.
Australia is currently experiencing a resources boom of historical dimensions. Its immediate cause is sustained rapid resource-intensive growth in China. Australia’s terms of trade have reached heights unknown on a sustained basis in the historical record. Australian exports are now (although in the 21st century decreasingly) more diversified away from commodities than they were through most of its history, so relative prices of commodities had to move higher than in earlier times to take overall terms of trade above peak levels in the late nineteenth and most of the 20th century.
After several years in which investment in expanding supply capacity lagged behind the lift in prices, the rates of growth of investment in the resources sector have been rising strongly since about 2005. Since the Global Financial Crisis of 2008, resources have been overwhelmingly the main contributor to exceptional growth in Australian business investment in general. Minerals and energy production and investment together are now larger relative to other sectors in the Australian economy than at any time since Federation.
The rising and eventually exceptionally high terms of trade kept Australian incomes and public revenue growth well above the rate of expansion of production for several years from 2003 to 2008. Commodity prices receded temporarily with the Global Financial Crisis. Since then, the growth of public revenues has been moderated by the effects of the exceptionally large capital expenditure in resources on deductions against income and resource rent taxes.
The rising terms of trade from 2003 allowed Australia to avoid what would have been a painful and probably recessionary end to a virulent early 21st century housing and consumption boom. The high rates of business investment in the resources sector have been a major factor in the strong economic growth performance of Australia relative to other developed countries in the aftermath of the Global Financial Crisis.
The resources boom has shifted the centre of gravity of national economic growth decisively to western and northern regions. This has challenged longstanding assumptions of Federal fiscal relations, which had been calibrated to redistribute public revenues from Victoria and New South Wales to the smaller states and the two territories.
The resources boom is global and not only national and so is changing fundamentally the environment for Australian international relations. Amongst our immediate neighbours, in Papua New Guinea, the China boom has provided the foundations from which the public finances have been rebuilt, economic stability restored and strong economic growth established after a decade of stagnation. Growth has been assisted in several Southeast Asian economies – although for a while less powerfully than might have been expected in Indonesia, as it grappled with the implications of the political decentralisation that accompanied the transition to democratic government at the beginning of the new century. Economic growth has been enhanced in Brazil, Chile and other resource-rich economies in Latin America (although not Mexico), which emerged from periods of difficulty in the 1990s into better economic times. Chinese investment and demand is incubating new projects and industries through many countries in Central Asia, the Middle East, Latin America and Africa. In Africa, a buoyant resources sector has been one element of a marked lift in economic growth trajectories in the early 21st century in all countries that are not experiencing high levels of political disorder. The boost from the new international resources environment has supported Russian economic performance and self-confidence, with implications running through domestic and international political arrangements. It has expanded the economic power of oil exporting countries in the Middle East.
For all of these reasons of national economic change and international relations, it is of great importance to Australian national policy to understand the origins and dynamics of the resources boom, its future dimensions, and its likely longevity and stability.
This paper focuses on the central cause of these changes rather than the wide-ranging implications. It begins with analysis of the economics of price determination in the resources sector. It examines the recent increases in prices for energy and metals and their origins in exceptional growth in Chinese demand. It shows that without China’s contribution, there may have been no growth in demand for many mineral resource products in the second half of the first decade of the 21st century. The paper examines the sources of especially strong growth of Chinese demand for resources. It discusses the prospects for continued growth and structural change in China, and how this will interact with wider developments in global supply and demand for resources to determine the longevity of the current Australian and global resources boom. In assessing possible future developments, the paper illustrates some possibilities from the experience of rapid economic growth in other Northeast Asian countries at earlier times, while noting differences between economies. It also analyses the implications for resources demand and prices of prospective structural change as China moves through the ‘turning point’ in economic development in which labour becomes relatively scarce and expensive (Lewis 1954; Ranis and Fei 1961, 1963; Minami 1973).
Here are the longer key sections:
The longevity of Australia’s China resources boom depends on the prospects for continued strong economic growth in China, on the resource intensity of that growth and on the extent to which the resource-intensive industries are integrated into international markets. These concluding remarks speculate about each of these factors in turn.
The first and second of the determinants of future import demand for energy and metals – the rate of economic growth and resources intensity – will be affected by scarcity of labour and the associated increases in real wages over the remainder of the 2010s.
China has entered the ‘turning point in economic development’, or rather, in a large and geographically differentiated economy, the ‘turning period’. This is the transition from a labour surplus economy with comparative advantage in labour-intensive products, to an increasingly diverse economy, with diverse comparative advantage centred upon capital-intensive and technologically sophisticated products (Cai 2010; Garnaut 2010 and other contributions to the special issue of the China Economic Journal, vol. 3, July 2010, Garnaut 2011c).
The large increases in real wages will reduce the profit share of income, and with it China’s prodigious savings rate. It will reduce the profitability of and, therefore, the incentives to invest in the labour-intensive industries that have played a major role in China’s growth over the three decades of the reform era.
But these developments will not necessarily reduce the investment rate. That depends on the expected profitability of investment. That, in turn, will be affected by productivity growth in the business sector and the effectiveness of provision of the public goods that become more critical to strong growth as incomes rise: regulatory systems, education, transport and communications amongst other services. If incentives to investment remain strong, the maintenance of a high investment rate can be reconciled with a falling savings rate through reduction in the current account surplus. This reconciliation is evident in the years since the Global Financial Crisis.
The quality of macroeconomic management also affects incentives to invest. The maintenance of macroeconomic stability will be more challenging through the transition out of the labour surplus economy. There is no need for rapidly increasing real wages to be associated with markedly higher inflation: this source of instability can be avoided through the combination of firm monetary policy and nominal appreciation of the currency. But there will be pressures for the authorities to appreciate too little and for inflation to accelerate to an extent that requires retrenchment and an otherwise unnecessary loss of growth potential.
My own assessment is that the investment share of expenditure will remain near the high rates of recent years until the middle of the current decade and then decline moderately.
The relative backwardness of China at the beginnings of internationally oriented reform and rapid growth, together with the magnitude of the obstacles to reform, means that economic growth can proceed at high rates for longer than in its Northeast Asian neighbours before productivity growth isslowed by proximity to the global frontiers. Some increase in total factor productivity growth will be generated by rising wages focussing attention on more economic use of scarce labour.
The third determinant of the rate of growth alongside investment rates and productivity increases is the labour supply. The total number of workers will soon begin to fall, and the fall will accelerate over time. Alongside decline in the total labour supply, there will be rapid increases in the stock of human capital per worker, as large increases in education expenditure are focussed
on declining numbers of school children.These perspectives on growth in the capital stock, productivity and labour supply are embodied in projections within a growth-accounting framework that I undertook for the Garnaut Climate Change Review. The projections took as their starting point Perkins and Rawski 2007. The projections, incorporating my own judgements on investment rates and productivity growth, pointed to average growth of output at a bit below 10 per cent 2009–2015 and then a bit below 7 per cent per annum 2015–2030 (Garnaut 2011d 1 ).
Something like this remains probable, although necessarily uncertain, and with the cycles associated with a market economy, and the inevitable bumps in the path of rapid, sustained economic growth.
So the prospect is for continued growth a bit below the average of the early 21st century to 2015 and then at about two-thirds of that level on average to 2030. At the end of the period, the Chinese economy would be about four times its current size.
How resource intensive will this growth be? Will Chinese growth turn out to be more like the highly energy- and metalsintensive growth of Korea (especially) and Taiwan, or more like the developed countries that reached high living standards at an earlier time in global economic development? Here, it is salutary to recall that Japan through the 1950s, 1960s and early 1970s followed a distinctively ‘Northeast Asian’ growth path with unusually high resource intensity, until high energy prices, focus on ‘resource security’, and policy driven by national economic strategy greatly reduced resource intensity from the late 1970s.
A continued high investment share of expenditure at least to 2015 is positive for high resource intensity of economic activity.
On the other hand, the high rate of urbanisation of the reform period so far will diminish, simply as a matter of arithmetic, now that around half of the Chinese are living in townships and cities. Moreover, and unlike almost any other country, there are some signs that anticipatory investment in transport and other urban infrastructure may reduce future investment demand.
Decelerating urban growth and recent high rates of urban investment are negative for high resource intensity in the future. High energy and metals prices and concerns about resources security have made efficient use of resources a major objective of policy in China – just as they did in Japan from the late 1970s. In China’s case, concern about global climate change has made the reduction in the greenhouse emissions intensity of production and consumption a major policy objective since about 2008 (Garnaut 2011a; Wen 2011). The climate change considerations will lead to lower rates of increase in energy use and a reduction in the emissions intensity of energy production. This is likely to be strongly negative for fossil fuel consumption, especially for coal. These influences are negative for metals intensity, more for energy intensity and most for fossil fuel intensity. The high export orientation of the Korean and Taiwan economies as they matured and developed new comparative advantage in capital-intensive products contributed to high resources intensity. China has entered a period in which the increase in the export share of output is decelerating. This is likely to continue. On this characteristic, China may end up in an intermediate position between Korea and Taiwan on the one hand, and the old, established industrial countries on the other.
Export orientation seems likely to be a neutral influence on future resources intensity, rather than positive as in Korea and Taiwan.
There are rather stronger factors pushing China in the direction of the resources intensity of Japan and the old industrial countries, than in the direction of Taiwan and Korea.
What is likely to happen to the import share of Chinese resources demand? The liberalisation of trade contributed a great deal to the increase in resources imports from the beginnings of reform in the late 1970s to late in the first decade of the 21st century. But this was a once-for-all positive influence on global metals and energy prices. Any further positive influence is likely to be balanced by the negative impact on resources demand of raising energy prices to global levels.
As in the 1960s, new institutional arrangements (the Chinese multinational corporation) and new suppliers (Papua New Guinea for nickel and several African and Latin American and Central Asian countries for a wide range of metals) are the focus of large investments. This will be moderately positive for the import share of resources demand, but not for the shares of established suppliers such as Australia.
It is likely that the Chinese economy will continue to grow strongly for the foreseeable future, although at moderately declining rates from about 2015. Resource intensity of production will decline rather more rapidly than seems to be the common expectation and more rapidly still as growth and the investment share of output fall from about 2015. Current global resources prices and investment levels seem to embody expectations of continued rapid growth in demand for resources along the lines of the early 21st century so far. This is encouraging huge expansion of supply of many energy and metallic minerals – all those for which there are opportunities in nature for large expansions of production at relatively low cost. The analysis of this paper suggests that these expectations may be disappointed. The next large adjustment forced by Australia’s China resources boom is likely to be to markedly lower terms of trade and resources investment.
I have been looking at long-term tendencies. China’s rapid growth involves economic, social and political change on a scale that is unprecedented in world history. It is unlikely to proceed over decades without bumps in the road, and an occasional dead end and detour. With China in the 2020s consuming more resource-based products from world markets than the whole of the currently developed world, the rest of the world will feel every bump through energy and metals markets.
Prices and investment in the resources sector are in their nature volatile. As the Australian economy is restructured to expand the role of the resources sector, the inevitable fluctuations in activity in China’s market economy will challenge Australia’s capacity to maintain economic stability.
This paper has been about the China resources boom, but global development does not end with China. The contemporary China resources boom may lead into a more widely based resources expansion, built on accelerated development in many developing countries. It would have to be truly widely based to fill the China gap in demand growth: no other large part of the developing world is likely to grow with anything like the resource intensity of China, although some countries, including India, may come to grow as fast. I leave the question of whether acceleration of growth elsewhere can make up for the anticipated deceleration in growth in China’s resources demand for others or another time.
Finally, one only has to identify the possibility of China absorbing more resource-based products than the currently developed world to raise some fundamental questions about ‘limits to growth’. The experience of development, and not only our theory, inform us that higher prices induce expansion of output and substitution in supply and demand for scarce resources, as well as some modification of the rate and pattern of economic expansion. But while, in the end, supply will equal demand at some higher level of global economic output, the process of adjustment is of great importance and can affect economic activity in the rapidly growing economies and elsewhere.
Another constraint is more fundamental. Economists who draw from the common scientific heritage of humanity are aware that modern economic growth could be prematurely disrupted and in some circumstances truncated by external environmental costs of modern economic growth. The risks to long-term growth can be ameliorated at small short-term economic cost through policy adjustments that internalise the external environmental damage. The limits to growth associated with pressure on natural resources are defined in practice by the capacity of our political systems to apply efficient policies (Stern 2007; Garnaut 2008, 2011a).
And the full paper:
